PSYCHEMEDICS CORP - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended June 30, 2020

or

Commission file number: 1-13738

PSYCHEMEDICS CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Registrant's telephone number including area code:         (978) 206-8220

Securities registered pursuant to section 12(b) of the act:

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X      No __

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X       No __

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes __     No X

The number of shares of Common Stock of the Registrant, par value $0.005 per share, outstanding at August 8, 2020 was 5,526,493.

PSYCHEMEDICS CORPORATION

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2020

INDEX

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME/(LOSS)

(in thousands, except per share amounts)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands, except per share amounts)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by the Company or statements made by its employees may contain forward-looking information that involves risks and uncertainties. In particular, statements contained in this report that are not historical facts (including but not limited to statements concerning earnings, earnings per share, revenues, cash flows, dividends, future business, growth opportunities, profitability, pricing, new accounts, customer base, market share, test volume, sales and marketing strategies, market demand for drug testing services in Brazil, U.S. and foreign drug testing laws and regulations, including, without limitation, Brazilian professional driver drug testing requirements, required investments in plant, equipment and people and new test development, the effect of the COVID-19 pandemic on our business, including its effects on our business and profitability, and on the well-being and availability of our employees, the continued operation of our testing facilities and loan forgiveness under the PPP program) may be “forward looking” statements. Actual results may differ from those stated in any forward-looking statements. Factors that may cause such differences include but are not limited to risks associated with the severity of the COVID-19 pandemic, and its impact on the Company’s markets, including its impact on the Company’s customers, suppliers and employees, as well as its risk on the United States and worldwide economies, the timing, scope and effectiveness of further governmental, regulatory, fiscal monetary and public health responses to the COVID-19 pandemic, compliance by the Company with repayment forgiveness requirements under the PPP, changes in U.S. and foreign government regulations, including but not limited to FDA regulations, changes in Brazilian laws and regulations and proposed laws and regulations and the implementation of such laws and regulations, currency risks, R&D spending, competition (including, without limitation, competition from other companies pursuing the same growth opportunities), the Company’s ability to maintain its reputation and brand image, the ability of the Company to achieve its business plans, cost controls, leveraging of its global operating platform, risks of information technology system failures and data security breaches, the uncertain global economy, the Company’s ability to attract, develop and retain executives and other qualified employees and independent contractors, including distributors, the Company’s ability to obtain and protect intellectual property rights, litigation risks, general economic conditions With respect to the continued payment of cash dividends, factors include, but are not limited to, all of the factors listed above with respect to the impact of the COVID-19 pandemic on the our business generally, plus cash flows, available surplus, capital expenditure reserves required, debt service obligations, regulatory requirements and other factors that the Board of Directors of the Company may take into account.

Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements represent the Company’s estimates and assumptions only as of the filing date of this Report. The Company expressly disclaim any duty to provide updates to forward-looking statements, and the estimates and assumptions associated with them, after the filing date of this Report, in order to reflect changes in circumstances or expectations, or the occurrence of unanticipated events, except to the extent required by applicable securities laws. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed above and under “Risk Factors” set forth in Part I Item 1A of the 10-K, as well as the risks and uncertainties discussed elsewhere in this Report. The Company qualifies all of its forward-looking statements by these cautionary statements. The Company cautions you that these risks are not exhaustive. The Company operates in a continually changing business environment and new risks emerge from time to time.

OVERVIEW

Revenue for the second quarter of 2020 was $3.3 million compared to $9.3 million in 2019, a decrease of 64%. The Company reported a net loss of $2.1 million, or $0.37 per diluted share for the three months ended June 30, 2020 versus net income of $0.8 million, or $0.14 per diluted share for the same period in 2019. Revenue and earnings decrease for the quarter were attributed to a reduction of domestic and international sales volume, primarily as a result of the coronavirus pandemic (“COVID-19”). Further contributing to the net loss were higher personnel costs, as the Company maintained personnel to comply with anticipated PPP loan forgiveness. However, the Company was not able to take the PPP loan forgiveness into income during the quarter (the higher personnel costs incurred during the period were not offset by the income from loan forgiveness) as the SBA has not formally forgiven the PPP loan. While we believe we will quality for loan forgiveness, this process will take several months. Revenue for the six months ended June 30, 2020 and 2019 was $10.9 million and $19.1 million, respectively, a decrease of 43%. The Company had a net loss for the six months ended June 30, 2020 of $2.2 million versus net income for the six months ended June 30, 2019 of $1.4 million. The Company declared $0.18 per share of cash dividends to its shareholders in the six months ended June 30, 2020. It is important to note that this dividend was declared in February 2020, following the release of year-end earnings, with no dividends declared thereafter. This compared to dividends declared of $0.36 per share for the six-month period in 2019.

As a result of being approached by third parties, our Board of Directors authorized the Company to explore strategic alternatives to enhance shareholder value. As a result of this process, during the quarter, the Company incurred increased legal costs. The Company does not intend to comment further or update the market with any further information on the process unless and until the Board of Directors has approved a specific action. There can be no assurance that this process will result in any definitive agreement, any specific action or change in current strategy.

RESULTS OF OPERATIONS

Revenue decreased 64% for the three months ended June 30, 2020 compared to the same period in 2019, primarily due to a 73% decrease in volume resulting from COVID-19, both domestically and internationally. For the same period, domestic revenues decreased $3.7 million (54%) and international revenues decreased $2.3 million (92%). For the six months ended June 2020, revenue decreased 43%, primarily due to a 53% decrease in volume. For the same period, domestic revenues decreased $4.4 million (32%) and international revenues decreased $3.9 million (74%). The Company’s domestic revenues were impacted by the shut-down of the economy due to COVID-19, with some lesser impact in safety sensitive industries. The international revenue decline was primarily from Brazil testing volume. Due to COVID-19, the Brazilian government extended the renewal period for drivers licenses to 18 months, causing a major fall off in volume and revenues from Brazil.

Gross profit (loss): The Company had a ($252) thousand gross loss for the three months ended June 30, 2020, compared to a $4.2 million gross profit for the same period in 2019. Direct costs decreased by $1.6 million or 30% for the three months ended June 30, 2019 compared to the same period in 2019. The margin was adversely impacted by lower sales volume as noted above. In addition, to qualify for future forgiveness of the PPP loan, the Company was required to maintain prior levels of personnel, which negatively impacted the margin. Gross profit for the six months ended June 30, 2020 decreased $6.1 million to $2.5 million for the comparable period in 2019. Direct costs decreased by $2.2 million or 20% for the six months ended June 30, 2020 when compared to the same period in 2019. The gross profit margin for the six-month period ended June 30, 2020 was 23% compared to 45% for the comparable period in 2019. The margin was adversely impacted by lower sales volume and continuation of prior year levels of personnel-related expenses as noted above.

General and administrative (“G&A”) expenses increased 37% or $0.5 million to $1.9 million for the three months ended June 30, 2020 compared to $1.4 million for the same period in 2019. As a percentage of revenue, G&A expenses were 56% and 15% for the three months ended June 30, 2020 and 2019, respectively. The increase in G&A expenses was driven by two items. The first is that the second quarter of 2019 had a credit for some legal expenses due to an insurance reimbursement. The second relates to a significant amount of legal expenses in the second quarter related to discussions we had regarding potential strategic transactions. As a result of being approached by third parties, our Board of Directors authorized the Company to explore strategic alternatives to enhance shareholder value. As a result of this process, the Company incurred increased legal costs. G&A expenses were $3.4 million and $3.3 million for the six months ended June 30, 2020 and 2019, respectively. As a percentage of revenue, G&A expenses were 31% and 17% for the six months ended June 30, 2020 and 2019, respectively.

Marketing and selling expenses decreased 21% or $0.2 million to $0.9 million for the three months ended June 30, 2020 compared to $1.1 million for the same period in 2019. Total marketing and selling expenses represented 26% and 12% of revenue for the three months ended June 30, 2020 and 2019, respectively. Marketing and selling expenses were $2.0 million and $2.2 million for the six months ended June 30, 2020 and 2019, respectively. As a percentage of revenue, marketing and selling expenses were 18% and 12% for the six months ended June 30, 2020 and 2019, respectively.

Research and development (“R&D”) expenses for the three months ended June 30, 2020 and 2019 were $0.3 million and $0.4 million, respectively. R&D expenses represented 10% and 4% of revenue for the three months ended June 30, 2020 and 2019, respectively. R&D expenses were $0.7 million and $0.8 million for the six months ended June 30, 2020 and 2019, respectively. R&D expenses represented 6% and 4% of revenue for the six months ended June 30, 2020 and 2019, respectively.

Provision for income taxes consists primarily of federal and state income taxes in the United Sates and income taxes in Brazil. We estimate income taxes in each of the jurisdictions in which we operate. During the three months ended June 30, 2020, the Company recorded a tax benefit of $1.3 million (effective tax rate of 39%) and a tax provision of $0.6 million (effective tax rate of 43%) for the comparative period in 2019. During the six months ended June 30, 2020 and 2019 the Company recorded a tax benefit of $1.5 million and a tax provision of $0.9 million for the comparative period in 2019. These provisions represented an effective tax rate of 40% for the six months ended June 30, 2020 and 2019.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2020, the Company had approximately $3.7 million of cash and $6.5 million of working capital. The Company's operating activities used $3.7 million of cash for the six months ended June 30, 2020. Investing activities used $0.7 million of cash while financing activities provided $0.9 million of cash during the first six months of 2020.

Cash used by operating activities of $3.7 million reflected net loss of $2.2 million adjusted for depreciation and amortization of $1.3 million, ROU asset amortization of $0.5 million and stock-based compensation of $0.3 million. This was also affected by an increase in current assets of $0.5 million and a decrease in accounts payable and accrued expenses of $2.6 million.

Cash used in investing activities of $0.7 million consisted primarily of costs related to leasehold improvements. We anticipate spending $0.3 million to $0.8 million in additional capital purchases for the remainder of 2020.

Cash provided by financing activities of $0.9 million primarily included proceeds from the PPP loan of $2.2 million, partially offset by cash dividends paid to shareholders of $1.0 million and payments on equipment financing of $0.3 million.

Contractual obligations and other commercial commitments as of June 30, 2020 include operating lease commitments and outstanding debt, described in Notes 7 and 8, respectively of the Notes to Condensed Consolidated Financial Statements.

At June 30, 2020, the Company's principal sources of liquidity included an aggregate of approximately $3.7 million of cash.  The Company had $6.5 million and $7.0 million of working capital as of June 30, 2020 and December 31, 2019, respectively. On May 4, 2020, the Company received SBA loan proceeds of approximately $2.2 million through the CARES act. While management currently believes that its existing funds and recently received loan proceeds should be adequate to fund operations for the next 12 months, economic conditions related to COVID-19 are expected to continue to adversely affect the Company’s operating results and cash flows. As a result, the Company has temporarily suspended its quarterly dividend until the economic situation stabilizes.

Item 4. Controls and Procedures

As of the end of the period covered by this report (the “evaluation date”) the Company’s management under the supervision and with the participation of the Company’s Chief Executive Officer and Vice President of Finance, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act. Based upon that evaluation, the Chief Executive Officer and Vice President - Finance concluded as of the evaluation date, that the Company’s disclosure controls and procedures were effective for ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that its disclosure controls and procedures were also effective to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the Company’s principal executive and principal financial officers, to allow timely decisions regarding required disclosure.

There has been no significant change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

Item 1A. Risk Factors

Risks associated with the Coronavirus (“COVID-19”).

The COVID-19 pandemic is expected to continue to materially affect the Company’s operating results during at least the next fiscal quarter and likely longer. In particular, the closing of drivers license bureaus in Brazil in response to COVID-19, along with other risk factors related to our operations in Brazil noted below, are expected to continue to have a material adverse impact on expected testing volume in Brazil for at least the next year. In addition, COVID-19’s effect on the world economy has caused significant increases in unemployment which has historically had a negative impact on our testing volume. COVID-19’s negative impact on the Company’s domestic and foreign-based revenue and operating results in the fiscal first quarter is anticipated to continue into the third quarter, and potentially beyond. However, this risk was mitigated in part by the Company’s recent receipt of proceeds from the CARES Act loan noted above.

While the primary COVID-19 related risk to the business is from reduced sales volume, there is also a risk from a disrupted supply chain or personnel availability. The Company has obtained additional supplies to reduce the impact of a disrupted supply chain, and has taken other protective measures to lessen the impact of COVID-19 on our own operations, including the use of personal protective equipment, enhanced cleaning and split shifts at our laboratory, however, there can be no assurance that our own operations will not be adversely impacted by COVID-19.

Risks associated with CARES Act PPP loan (“loan”)

Under the CARES Act, loan forgiveness is available for the sum of documented payroll costs, covered rent payments and covered utilities during the twenty four-week period beginning on the date of loan approval. We will be required to repay any portion of the outstanding principal that is not forgiven, along with accrued interest. While we believe we satisfied all eligibility criteria for the loan, and that our receipt of the loan is consistent with the broad objectives of the CARES Act, it is possible that the SBA or another federal agency will determine that we were ineligible to receive the loan, in which event we would be required to repay the loan. In addition, if these events were to transpire, they could have a material adverse effect on our business, results of operations and financial condition.

We are subject to numerous political, legal, operational, business and other risks as a result of our international operations which could impact our business in many ways.

Although we conduct a majority of our business in the United States, over the last several years, a significant portion of our business has been derived from Brazil. As we have previously disclosed, our international operations increased our exposure to the inherent risks of doing business in international markets, including, without limitation, changes in the local economic environment and local laws and regulations, the Company’s reliance upon one distributor in Brazil and potential competition from third parties doing business in Brazil. Also as previously noted, the Company’s distribution agreement with its Brazilian distributor may be terminated for any reason by either the Company or its distributor following 90 days’ written notice and is non-exclusive to the Company.

International operations also require us to devote significant management resources to implement our controls and systems in foreign markets, to comply with the U.S. Foreign Corrupt Practices Act and similar anti-corruption laws in non-U.S. jurisdictions and to overcome challenges based on differing languages and cultures.

Except as noted above, there have been no material changes in our risk factors from those disclosed in the 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no purchases of treasury stock in the first six months of 2020.

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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